MODULE 4: Risk and Reward: Individual Decision

Vocabulary flashcards covering key terms and concepts from Module 4 on individual decision making, utility theory, and cost/benefit analysis.

Risk Averse

A classification of a decision maker who is always willing to accept a smaller cash-certain amount than the expected value of a gamble.

Risk Neutral

A classification of a decision maker who is indifferent between a cash-certain amount and a gamble with an expected value equal to that cash-certain amount, graphically represented as a $45\text{-degree}$ linear function.

Risk Seeker

A classification of a decision maker who demands a cash-certain amount in excess of the expected monetary payoff of a gamble, with a utility function rising at an increasing rate.

Expected Utility Theory

An individual decision-making model developed by Von Neumann and Morgenstern in $1947$ which posits that decisions are made to maximize expected utility rather than expected monetary value.

Util

A mathematical unit of measure that represents the utility, or benefit, derived from a particular choice or level of wealth.

Certainty Equivalent

The cash-certain amount of wealth that yields the exact same utility as a gamble, representing the amount of expected value an individual is willing to give up to eliminate uncertainty.

Opportunity Cost

The value or benefit of the next best alternative activity foregone when making a choice.

Reservation Price

The minimum amount of compensation that must be offered to induce an individual to undertake an activity.

Marginal Cost

The additional cost incurred by engaging in one additional unit of an activity.

Marginal Benefit

The additional benefit or gain realized from engaging in one additional unit of an activity.

Sunk Costs

Costs that do not change regardless of the decision made, are incurred regardless of the outcome, and should be ignored in decision-making calculations.

Externalities

Costs or benefits of a decision that affect third parties not involved in the decision-making process, categorized as positive or negative.

Normative Question

A type of decision-making or economic question that focuses on what should be.

Positive Question

A type of decision-making or economic question that focuses on what the consequences will be.